The U.S. financial markets really liked the federal takeover of mortgage giants Fannie Mae and Freddie Mac. The Dow Jones Industrials were up 1.24 percent when last I checked though that was down significantly from its open.

What's not to like? By stepping in, the feds kept the two companies which either hold or back more than $5 trillion of U.S. mortgage debt from collapsing.That pretty much would have ended the world as we know it, at least the financial world.

Well, there some features of the bailout package not to like, according to Doug Elmendorf, a senior fellow at the Brookings Institution think tank who has worked at the Federal Reserve, Treasury Department, White House Council of Economic Advisers and Congressional Budget Office.

His problems are with the way the rescue will continue payment to some bondholders who should have suffered a similar fate to shareholders, who were wiped out.

Also, he doesn't like how the rescue requires the Treasury Department and the two government-sponsored enterprises or GSEs, as the companies are called, to continue to purchase mortgage-backed securities.

Here's his analysis:

"The rescue plan for Fannie Mae and Freddie Mac announced this weekend is mostly very good: The plan keeps the companies' operations going, which is absolutely necessary for financial and economic stability. The plan does not bail out the existing shareholders but mostly limits the government's financial investment to the amount needed to bring the enterprises back to positive net worth. The plan recognizes that we cannot immediately restructure Fannie and Freddie to fix their hybrid public-private nature, but it ensures that the government has full control over the enterprises so that long-run decisions about our system of housing finance can be made in the best interest of society as a whole.

"However, I have concerns about two pieces of the plan: the continuation of payments to the subordinated debt holders, and the purchase of additional mortgage-backed securities by Fannie, Freddie, and the Treasury. Continuing payments to this set of debt holders will help to stabilize financial markets. However, the crucial role of subordinated debt for any company is to create a group of investors who know they will lose if the company fails, so that they scrutinize and attempt to influence the company's actions, and so that the price of the debt is a visible signal of the perceived risk of the company failing. By continuing to make payments on Fannie and Freddie's subordinated debt, the rescue plan risks setting a precedent for rescues of other financial institutions and thereby undermining this market discipline.

"The purchase of additional mortgage-backed securities for the Fannie and Freddie portfolios (up to roughly $150 billion) and for the Treasury (in unspecified amounts) will offset some of the recent fall in demand caused by a pullback of foreign and domestic investors. Thus, the purchases serve a worthy short-term stabilizing role in the mortgage market. However, increasing the size of Fannie and Freddie's portfolios goes in the opposite direction of the appropriate long-run goal to reduce the scale of these enterprises (however we resolve the public-private problem). Moreover, direct Treasury purchases of mortgage-backed securities are a significant new step toward a larger government role in supplying funds for housing, which may complicate an appropriate long-run resolution of the public-private hybrid problem.

Comments

Welcome to the socialistic Wall Street gentry !! Every time, one of their sectors gets caught with their hands in the cookie jar, they don't go to jail, like we would, they get a bailout !! How is that for nonsense capitalism !! Enjoy our money, boys and girls of Wall Street and be prepared to really get a nice windfall, when the Bush-McCain Republicans fork over our Social Security Funds to you. You can misspend, misappropriate and, downright, steal those funds !! Have another Rolls-Royce, on us, the taxpayers !!
SUPPORT OUR TROOPS, BRING THEM HOME, ALIVE AND WHOLE. NOW.

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